To the extent that a portfolio has capital gains in it, these changes can be hugely significant. The significance in respect of the tax suffered on the entire portfolio will depend on the balance between income (dividends, interest and rent) and capital gains. That is without considering the effective rate of tax at which the various income and capital flows are taxed at fund and investor level.
The complexities of life fund taxation are something to behold and involve consideration of the combined impact of the indexation allowance, the deemed annual realisation of collectives and the spreading of the deemed gains over seven years, reserving for tax on unrealised gains, non-taxation of UK dividends and the offset of any withholding tax on foreign dividends.
Naturally, all this has an impact on the effective overall rate of tax borne by the investor. For investors in UK life funds, as you will all know, a 20 per cent tax credit is available regardless of the effective rate of tax actually suffered at fund level.
Offshore bond taxation is considerably easier. There is nil tax at fund level, with little or no chance of the life fund reclaiming any withholding tax, and gains subject to tax when realised by the investor, with no tax credit.
UK collectives are fully transparent, with received or reinvested income assessable, although with no further tax payable by basic-rate taxpayers, and realised gains subject to 18 per cent tax if they exceed the annual exemption and regardless of the investor’s income level.
There are some potentially interesting anomalies for UK investors in offshore distributing funds – possibly to be renamed reporting funds in the future – as a result of the availability of a 10 per cent non-payable tax credit equal to one-ninth of the distribution made. A more usual way to express this tax credit will be as 10 per cent of the grossed- up dividend.
The £5,000 overall foreign dividend limit for this treatment suggested in the 2007 pre-Budget report has been scrapped. The credit will be available in 2008/09, provided the individual has a shareholding in the non-UK company, including funds treated as companies, that is less than 10 per cent of the shares in that company.
It is also stated that from April 6, 2009, the 10 per cent limit will be removed and, to be eligible for the credit, the non-UK company’s country of residence must levy tax on that company’s corporate profits similar to UK corporation tax.
There will also be anti-avoidance measures to ensure that these new rules are not subject to abuse. It does seem that, initially at least, any possible anti-avoidance measures will not apply to investors who have less than 10 per cent of the shares in the non-UK company. This will be the case for most investors in offshore retail funds.
Much of the discussion to date has been about the most tax-appropriate vehicle in which to accumulate funds. Most of the comparisons have concentrated on capital gains, with the unsurprising result that collectives look best. Others have, however, stated the importance of also considering income. There is also the need to consider how and when benefits are taken from the investment, either from outset or from the end of a period of accumulation.
It is in making this comparison that very careful thought needs to be given to the tax rules in respect of different types of withdrawal on different occasions during the investor’s lifetime. On death, collectives deliver tax-beneficial re-basing, that is, an uplift in the cost price to the value of the investment on the death of the investor.